Mastering Charitable Contribution Deduction Rules and...
Transcript of Mastering Charitable Contribution Deduction Rules and...
WHO TO CONTACT
For Additional Registrations:
-Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10)
For Assistance During the Program:
-On the web, use the chat box at the bottom left of the screen
If you get disconnected during the program, you can simply log in using your original instructions and PIN.
IMPORTANT INFORMATION
This program is approved for 2 CPE credit hours. To earn credit you must:
• Participate in the program on your own computer connection (no sharing) – if you need to register
additional people, please call customer service at 1-800-926-7926 x10 (or 404-881-1141 x10). Strafford
accepts American Express, Visa, MasterCard, Discover.
• Listen on-line via your computer speakers.
• Respond to five prompts during the program plus a single verification code. You will have to write down
only the final verification code on the attestation form, which will be emailed to registered attendees.
• To earn full credit, you must remain connected for the entire program.
Mastering Charitable Contribution Deduction
Rules and Completing Form 8283 Navigating Substantiation and Appraisal Requirements, Leveraging Carry-Forwards, and Avoiding AAOI
THURSDAY, JULY 30, 2015, 1:00-2:50 pm Eastern
Tips for Optimal Quality
Sound Quality
When listening via your computer speakers, please note that the quality
of your sound will vary depending on the speed and quality of your internet
connection.
If the sound quality is not satisfactory, please e-mail [email protected]
immediately so we can address the problem.
Viewing Quality
To maximize your screen, press the F11 key on your keyboard. To exit full screen,
press the F11 key again.
FOR LIVE EVENT ONLY
July 30, 2015
Mastering Charitable Contribution Deduction Rules and Completing Form 8283
Thomas T. Brooks, CPA/ABV, ASA
Cherry Bekaert
David C. Hogan
Ronald Blue & Co. CPAs and Consultants
Joseph K. Beach, Esq.
Merritt Watson
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
MASTERING CHARITABLE CONTRIBUTION DEDUCTIONS
David C. Hogan
Ronald Blue & Co. CPAs and Consultants
Mastering Charitable Contribution Deduction
• What motivates our clients to give?
Tax Benefits
Estate Planning
Satisfaction of giving back
Religious convictions
• Our role in charitable planning is to help clients satisfy their
charitable desires in a tax efficient manner.
• We also must help them adequately substantiate their
contributions in order to withstand IRS scrutiny.
6
Mastering Charitable Contribution Deduction
• What we will cover:
Charitable Contribution deduction limitations.
Required Substantiation of charitable contributions.
Utilization of charitable contribution carryforwards
Anticipatory assignment of income
Appraisal Requirements
Form 8283
7
Charitable Contributions
For Individuals, a deduction is allowed for charitable contributions, but only
if the requirements of IRC §170 are met.
IRC §170 also sets the annual deduction limits.
Generally, you can deduct contributions of money or property you make to, or
for the use of, a qualified organization. A contribution is “for the use of” a
qualified organization when it is held in a legally enforceable trust for the
qualified organization or in a similar legal arrangement.
The contributions must be made to a qualified organization and not set aside
for use by a specific person.
IRS Publication 526
8
Contributions You Cannot Deduct
IRS Publication 526 outlines some specific donations that you cannot deduct:
• A contribution to a specific individual,
• A contribution to a nonqualified organization,
• The part of a contribution from which you receive or expect to receive a benefit,
• The value of your time or services,
• Your personal expenses,
• A qualified charitable distribution from an IRA,
• Appraisal fees,
• Certain contributions to donor advised funds, or
• Certain contributions of partial interests in property.
Detailed discussions of these is found in IRS Publication 526.
9
Deduction Limitations for Individuals
Charitable contribution deductions are subject to annual limits of 50%, 30%,
or 20% of Adjusted Gross Income (AGI).
Contributions exceeding the applicable limit may be carried over and
deducted in a later year (generally 5 years).
10
50% Contribution Limit
The overall annual limit on the charitable contribution itemized deduction is
50% of AGI. This limit could include 50%, 30%, or 20% contributions.
Within the overall limit, contributions (other than capital gain property) to
50% organizations are limited to 50% of AGI.
11
50% Organizations
A 50% organization is defined in §170(b)(1)(A).
Generally, 50% organizations include churches, schools, hospitals,
governmental entities, private operating foundations, and other nonprofit
agencies organized for charitable, religious, educational, scientific, or
literary purposes.
12
30% Contribution Limit
There are two 30% contribution limits:
1. Cash and property other than capital gain property donated to 30%
organizations.
2. Long-term capital gain property donated to 50% charities
This is important because it potentially provides for a second 30% limit that
can be combined to reach the 50% overall limit.
13
Long-term capital gain property
• Generally, a contribution of long-term capital gain property is measured
by the assets fair market value and gifts to 50% organizations are limited
to 30% of AGI (20% for 30% organizations).
• An election is allowed to limit the deduction to the tax basis of the
property and utilize the 50% limitation.
• This could be a valuable planning technique if the asset his not highly
appreciated and the taxpayer has exceeded the 30% limit.
• However, the election is irrevocable and must be applied to all gifts that
would fall under the 30% limitation (including carryforwards).
14
30% Organizations
30% Organizations are defined in §170(b)(1)(B).
Common charities in this group include veterans organizations, domestic
fraternal societies, nonprofit cemeteries, and certain private foundations.
15
20% Contribution Limit
Capital gain property contributed to a 30% charity is subject to a 20%
limitation.
Most often this occurs with a donation of capital gain property to a family
funded private foundation.
16
Applying the Contribution limits
The different contribution limitations are applied in the following order:
1. Contributions subject to the 50% limitation
2. Contributions subject to the 30% limit, up to the lesser of:
• 30% of adjusted gross income, or
• 50% of adjusted gross income minus your contributions to 50% limit organizations, including contributions of capital gain property subject to the special 30% limit.
3. Contributions of capital gain property subject to the special 30% limit, up to the lesser of:
• 30% of adjusted gross income, or
• 50% of adjusted gross income minus your other contributions to 50% limit organizations.
4. 20% limitation
Contributions exceeding any one limitation category, or the overall 50% limit, are carried forward for five years. (§170(d)
17
Contribution Carryovers
• Contributions carried over are subject to the same percentage limitations
in the year to which they are carried.
• Current contributions in each category are deducted first. Next, within
that category, amounts carried over are deducted, up to the limitation
amount for the category. Then, the same process is applied to the next
limitation category.
• If you have carryovers from 2 or more years, you must use the earlier
years first.
• A carryover of a contribution to a 50% limit organization (including capital
gain property subject to 30% limit) must be used before contributions in
the current year to 30% organizations.
18
Substantiation Requirements
The required substantiation varies based on whether the contribution is in
cash or property and amount of cash or value of the property donated. We’ll
cover:
• Cash
• Publicly Traded Stock
• Nonpublicly traded Stock
• Artwork
• Other noncash
• Vehicles
• Out-of-pocket expenses while serving as a volunteer
19
Cash Contributions less than $250
Less than $250 - A donor cannot claim a tax deduction for any contribution
of cash, a check or other monetary gift unless the donor maintains a record of
the contribution in the form of either a bank record (such as a cancelled
check) or a written communication from the charity (such as a receipt or
letter) showing the name of the charity, the date of the contribution, and the
amount of the contribution. IRS Publication 1771 §170(f)(17)
Note that this was added by the 2006 Pension Protection Act and there is no
de minimus exception. This isn’t new, but still catches some taxpayers by
surprise.
20
Cash Contributions more than $250
§170(f)(8) Substantiation requirement for certain contributions.
General rule. No deduction shall be allowed under subsection (a) for any
contribution of $250 or more unless the taxpayer substantiates the
contribution by a contemporaneous written acknowledgment of the
contribution by the donee organization that meets the requirements of
subparagraph (B).
Note that this is required of any contribution in excess of $250, not just
cash.
21
Content of acknowledgement
Acknowledgement must contain:
• the name of the charitable organization,
• the amount of cash contributions with a list of dates contributed, and
• a statement that no goods or services were provided by the organization
(or a good faith estimate of the value of any goods or services that were
provided).
22
Contemporaneous
The documentation must be obtained prior to the filing of the tax return, or,
if earlier, the due date of the return (including extensions). The IRS will not
accept substantiating documentation received after the return has been
filed. §170(f)(8)(C)
Any receipt obtained after filing the return is not contemporaneous and will
jeopardize the deductibility.
23
Contemporaneous
Courts have consistently sided with the IRS in following the letter of the law.
In Durden v Commissioner, neither the IRS, nor the court, disputed the
amount or intent of the donation, but it was disallowed because the receipt
was not deemed adequate. It did not contain the required language stating
that “taxpayer received no goods or services in consideration for the
contribution.”
A subsequent receipt containing the proper language was not allowed because
it was not contemporaneous.
24
Publicly Traded Stock or Securities
Required Substantiation:
• In addition to the requirements of §170(f)(8)(A) & (B), the
acknowledgement must contain a description of the property.
• The taxpayer must also have reliable records that include the fair market
value of the property.
Note that the charity is not required to provide the FMV of the securities, but
the taxpayer must be able to substantiate.
25
Other Noncash Property
• For other noncash property, including nonpublicly traded stock, artwork or
other long-term capital gain property valued at $5,000 and less, the rules
are the same as just described.
• Donated property valued in excess of $5,000 must also have a Qualified
Appraisal.
Furthermore, the appraiser must sign Declaration of Appraiser and the
Donee organization must sign acknowledgement on page 2 of Form 8283.
26
Vehicles, Boats or Airplanes
IRS Publication 4303
27
Vehicles, Boats or Airplanes
The amount you may deduct for a vehicle contribution depends upon what
the charity does with the vehicle as reported in the written acknowledgment
you receive from the charity.
If the charity sells the vehicle, generally your deduction is limited to the
gross proceeds from the sale. However, there are certain exceptions.
28
Vehicles, Boats or Airplanes
29
Out-of-pocket expenses
Acknowledgment from charity must contain
1. a description of the services provided,
2. a statement as to whether the charity provided any goods or services in
return for the services and if so, a description and a good faith estimate
of their value.
The acknowledgment must be contemporaneous. It does not have to list or
value the out-of-pocket expenses, but the expenses must be substantiated by
the volunteer.
30
31
32
33
ANTICIPATORY ASSIGNMENT OF INCOME
Joseph K. Beach, Esq.
Merritt Watson
34
Anticipatory Assignment of Income
Your long-time client, Bob, sent you an email yesterday. It looks
something like this:
Hope you have been doing well. Remember when you told me that we
should talk before I sold my business? I think we will close at the end
of August so I can relax over Labor Day. Didn’t you say I could get out
of some tax if gave part of the business to charity? Anywho, we’ve
about got this thing wrapped up. Let me know if I need to sign
anything to get a deduction.
Bob
35
Anticipatory Assignment of Income
What do you tell Bob?
Is it too late to help him?
Do you need more information?
If you need more information, what questions should you ask Bob?
36
Anticipatory Assignment of Income
Palmer v. Commissioner, 62 T.C. 684 (1974),
aff ’d on another issue, 523 F.2d 1308 (8th Cir. 1975)
Ruling:
“[A] gift of appreciated property does not result in income to the
donor so
long as he gives the property away absolutely and parts with the title
thereto
before the property gives rise to income by way of a sale.”
Facts:
Taxpayer gifted stock to foundation of which he was in control of and
the next
day the corporation redeemed the stock.
37
Anticipatory Assignment of Income
Rev. Rul. 78-197
IRS acquiesced to Palmer ruling.
Service stated that it would treat redemption proceeds as income to
the donor only if the charity is legally bound (or could be compelled) to
surrender shares.
38
The Boat Thing –
Blake v. Commissioner 697
F.2d 473
(2d Cir. 1982)
Anticipatory Assignment of Income
39
Anticipatory Assignment of Income
Taxpayer had an understanding with charity that it would use the
proceeds from the sale of stock it received from the taxpayer to
purchase a yacht from the taxpayer.
Taxpayer pursued transaction against advice of counsel.
Taxpayer tried to secure a charitable deduction and a capital loss.
At trial, the taxpayer noted that “…he would not have made a
donation as substantial as the amount of the market value of the stock
he transferred “except for the boat thing.””
Tax Court ruled for the IRS and the Second Circuit affirmed.
40
Anticipatory Assignment of Income
Greene v. United States, 13 F.3d 577 (2d Cir. 1994)
Taxpayer contributed futures contracts to a private operating foundation
he created.
Taxpayer had obtained a private letter ruling stating that he would be
entitled to a deduction for the fair market value of the contracts on the
date of the gift.
An intervening law change stated that only 60% of the gain would be
long-term capital gain.
41
Anticipatory Assignment of Income
Greene v. United States, 13 F.3d 577 (2d Cir. 1994) - Continued
Lower court ignored the relationship between the donor and the charity.
Court further found that taxpayer kept no control and that the Service
should not have been surprised that the charity sold the contracts.
The Second Circuit Court of Appeals also weighed in on the step-
transaction doctrine and discussed the end result test, the mutual
interdependence test, and the binding commitment test.
42
Anticipatory Assignment of Income
Greene v. United States, 13 F.3d 577 (2d Cir. 1994) - Continued
End Result Test – Separate transactions will be collapsed if parts of a
single transaction intended to achieve an ultimate result.
Mutual Interdependence Test – Separate transactions will be collapsed if
they are so interdependent that legal relations created would be fruitless
without the completion of the series.
Binding Commitment Test – Separate transactions will be collapsed if
there is a legal obligation after the initial step for the remaining steps to
occur.
43
Anticipatory Assignment of Income
Ferguson v. Commissioner, 108 T.C. 14 (1997)
Sequence of events - taxpayers signed a merger agreement, board
approved, taxpayers created donation-in-kind records, broker created
separate accounts, charities formed, more than 50% of the shares tendered,
broker transferred shares to charities when 95% of the shares tendered,
merger occurred.
Taxpayers argued that the gifts were made when donation-in-kind
records were created, but the foundations were not created until several
days later.
When the taxpayers actually relinquished control, the charity had no
ability to stop the transaction.
44
Anticipatory Assignment of Income
Rauenhorst v. Commissioner, 119 T.C. No. 9 (2002)
Sequence of events – taxpayer received warrant, letter of intent to
purchase shares, board approves resolution to negotiate, taxpayer assigned
warrant to charities, taxpayer agreed to sell its remaining rights, charities
signed agreement to sell their warrants, businesses signed agreement for
purchase of stock, deal closed.
Tax Court ruled that IRS could not argue against Rev. Rul. 78-197 since
the ruling had not been revoked or modified.
The charitable donation took place between the signing of the letter of
intent and the agreement to sell the warrants.
45
Anticipatory Assignment of Income
What about Bob?
In counseling taxpayers, we need to find out the facts.
Is there a letter of intent?
Is there a written agreement?
Is there an oral agreement?
Are there any contingencies in the deal?
If there are contingencies, who controls them?
46
Anticipatory Assignment of Income
No really, what about Bob – and the purchaser?
Can Bob even transfer part of the business to the charity (e.g., Would Bob
be violating a franchise agreement?)?
Is it a friendly buyer (Will the buyer walk?)?
Does Bob have donative intent?
Are the parties in good health?
Do the parties need to make a deal?
Are there other options?
47
CHARITABLE REMAINDER TRUSTS
Joseph K. Beach, Esq.
Merritt Watson
48
Charitable Remainder Trusts
Brief Overview
CRTs are created under Section 664 of the Internal Revenue Code.
IRS provided sample forms for annuity trusts in Rev. Procs. 2003-53 to
2003-60.
IRS provided sample forms for unitrusts in Rev. Procs. 2005-52 to 2005-59.
Forms are annotated and contain alternate provisions.
CRTs can be inter vivos or testamentary.
CRTs can be paid to the non-charitable beneficiary over a term of years, a
lifetime, or two lifetimes (consecutively or concurrently and consecutively).
49
Charitable Remainder Trusts
Brief Overview - Continued
Additional contributions can be made to unitrusts.
Unitrust payment can be calculated differently (e.g., NIMCRUT).
Annuity payment can be stated in dollars instead of percentage.
Service permitted division of CRT upon divorce. Rev. Rul. 2008-41,
PLR200744019, PLR201029002. Service previously ruled on early
termination and division(PLR200304025), but will no longer rule on this
matter (Rev. Proc. 2015-3).
50
VALUATION FUNDAMENTALS FOR CHARITABLE GIFTING
Thomas T. Brooks, CPA/ABV, ASA
Cherry Bekaert
51
Appraisals of Privately Held Business
Interests for Charitable Purposes
Generally necessary for items of property for which
taxpayer claims a deduction greater than $5,000.
Also must attach Section B of Form 8283.
If a deduction of $500,000 or greater is claimed,
taxpayer must attach a qualified appraisal with Form
8283.
52
Qualified Appraisal
Performed by a qualified appraiser
Meets the relevant requirements of Regulations section
1.170A-13(c)(3) and Notice 2006-96, 2006-46 I.R.B. 902
Related to an appraisal made not earlier than 60 days
before the date of contribution of the appraised
property (i.e., valuation date must be 60 days or less
prior to the gift date).
Does not involve a prohibited appraisal fee.
53
Qualified Appraisal Cont.
Includes the following information:
Description of the property.
Physical condition of tangible property.
Date (or expected date) of contribution
Terms of any agreement or understanding entered into by donor (i.e., restrictions on donated property).
Name, address, and taxpayer identification number of qualified appraiser or of the appraiser’s firm.
Qualifications of qualified appraiser.
Statement that appraisal prepared for income tax purposes.
Valuation date(s).
Appraised fair market value on the date (or expected date) of contribution.
Method(s) of valuation used to determine the fair market value.
Specific basis for the valuation.
54
Qualified Appraiser
An individual who meets all of the following requirements:
Earned an appraisal designation from a recognized professional organization for demonstrated competency in valuing the type of property being appraised, OR
Has met certain minimum education and experience requirements.
Regularly prepares appraisals.
Demonstrates verifiable education and experience in valuing the type of property being appraised.
Has not been prohibited from practicing before the IRS.
Is not an excluded individual.
Appraiser must complete Form 8283, Section B, Part III.
55
Appraiser Penalties
Under Pension Protection Act of 2006, IRS has authority to penalize and seek injunctions against appraisers.
Requirements:
Prepared in conjunction with a return or claim for a refund.
Appraiser needs to know or has reason to know that appraisal will be used for such purpose.
Must result in a “substantial valuation misstatement” or a “gross valuation misstatement.”
56
Appraiser Penalties Cont.
Substantial valuation misstatement:
Value of the property appraised is 150% or more
of the amount to be determined to be the correct
value.
Gross valuation misstatement:
Also includes a substantial valuation
misstatement; therefore, thresholds are not
relevant to the appraiser penalties. Once
substantial valuation misstatement applies,
appraiser penalties apply.
57
Appraiser Penalties Cont.
The amount of the penalty is the lesser of:
1.The greater of:
10% of the amount of underpayment or
$1,000, OR
125% of the gross income received from
the preparation of the appraisal.
58
Fair Market Value
Fair market value (FMV) definition from
Revenue Ruling 59-60:
the price at which the property would
change hands between a willing buyer and a
willing seller, neither being under any
compulsion to buy or sell and both having
reasonable knowledge of the relevant facts.
59
FMV Factors to Consider
Nature of the business and history from its inception.
Economic outlook and condition and outlook of the specific industry.
Book value of the stock and financial condition of the business.
Earnings capacity of the business.
Dividend paying capacity.
Whether or not the enterprise has goodwill or other intangible value.
Sales of the stock and the size of the stock to be valued.
Market prices of stock of corporations engaged in the same or similar line of business where such stocks are actively traded in a free and open market.
60
Asset Approach
Market Approach
Similar Transaction Method
Guideline Company Method
Prior Transaction Method
Income Approach
Single Period Capitalization Method
Discounted Cash Flow Method
Each approach should be considered in any valuation engagement
Generally Accepted Valuation Approaches
61
Which Approach is the Right One?
Income Approach – When the target’s future
performance is expected to differ greatly from its
past performance as is the case with start-ups or
early stage businesses
Market Approach – When information on truly
comparable publicly traded companies or recent
transactions is readily available
Asset Approach – When the assets are the business
62
Asset Approach
Based on the economic principle of substitution
Involves balance sheet analysis and separate valuation of each item on the balance sheet
Estimates cost of all tangible and intangible assets net of depreciation and amortization
63
Asset Approach
Strengths
Useful in valuing holding companies and asset intensive businesses
Useful if company is to be liquidated
Weaknesses
Does not focus on the income produced by the assets
Difficult to value intangible assets
The greater the intangible value the less precise this approach becomes
Not very applicable in minority interest valuations
64
Market Approach
Also based on the economic principle of substitution
Compares entity being appraised to comparable publicly traded companies or comparable entities which have been recently acquired in arm’s-length transactions
Allows various market-based valuation multiples to be developed (i.e., price-to-earnings, invested capital-to-assets, invested capital-to-cash flow, etc.)
Adjust market multiples and apply to subject company
65
Market Approach
Strengths
Based on arm's-length transactions
Direct method of valuation if comparable companies can be found
Large pool of data
Relatively easy to obtain data
Weaknesses
Are guideline companies truly comparable?
Must make sure that data is truly comparable
66
Income Approach
Generally, the present value of an income stream to be generated over the entity’s remaining economic life
Premise: value deposits on future cash return to owner(s)
Closest of the three approaches to pure theory
Two methodologies: single period and multiple period
Involves four steps:
1. Projection
2. Set a horizon date/year
3. Calculate horizon (terminal year)
4. Calculate/apply a discount rate
67
Income Approach
Strengths
Theoretically valid (closest to “pure” value theory)
Intuitively satisfying
Spreadsheet compatible
Hopefully, projections incorporate real perspective
Weaknesses
Potentially biased projections
Can be very difficult to project (i.e., crystal ball)
How long should projections be?
Terminal value is often large
Discount rate is subjective
68
Income Approach – Key Terms
Discount rate – a yield rate used to convert future
payments or receipts into present value. This
represents the total rate of return an investor expects
to realize.
Capitalization rate – any divisor (usually expressed as a
percentage) that is used to convert income to value.
This rate only equals the discount rate when the
income capitalized represents the expected income
level into perpetuity.
69
Components of the Discount Rate
“Risk-free” rate* 20-year, 5-year, or 30-day Treasury yield as of
valuation date
+ Equity risk premium
Long-, intermediate-, or short-horizon equity
premium (corresponding to “risk-free” yield above)
In CAPM, this is multiplied by “beta”
+ Size premium “Small stock” premium: equity under $150 million
(also low-cap and mid-cap premiums available)
± Specific risk Specific risk difference in subject company relative
to companies from which above data drawn
*Note: The “risk-free” rate actually has one element of risk: “maturity risk”
(sometimes called “interest rate risk” or “horizon risk”) – the risk that the
value of the bond will fluctuate with changes in the general level of interest
rates.
70
Capital Asset Pricing Model - CAPM
Re = Rf + [ Beta x (Rm - Rf)]
Where:
Re = the expected return
Rf = the risk free rate
Beta = systematic risk
Rm = the return on the market in its entirety
Rm - Rf = the long term average risk premium of the market
as a whole over the long term average risk free rate
(also known as the equity risk premium)
71
Modified CAPM
Re = Rf + [ Beta x (Rm - Rf)] + SCP
Where:
Re = the expected return
Rf = the risk free rate
Beta = systematic risk
Rm = the return on the market in its entirety
Rm - Rf = the long term average risk premium of the market
as a whole over the long term average risk free rate
(also known as the equity risk premium)
SCP or “alpha” = Specific Company Risk Premium
72
The Build-up Method
Risk free rate 5.0%
Equity Risk Premium 6.5%
Small Company Risk Premium 4.6%
Specific Company Risk Premium 3.0%
Discount Rate 19.1%
Less: Long Term Growth 4.0%
Capitalization Rate 15.1%
73
Weighted Average Cost of Capital (WACC)
(de x Ce) + (dd[1-t] x Cd)
Where:
de = Required rate of return for the company’s equity capital
dd = Company’s cost of borrowing
Ce = Percentage of equity capital in the company’s capital structure
Cd = Percentage of debt capital in the company’s capital structure
t = Company’s effective income tax rate
74
Types of Adjustments
Balance sheet
Income statement
Other (discounts and premiums)
75
Levels of Value
$12 per share Synergistic
(strategic) value
20% strategic acquisition premium
Value of control shares
A combined 30% minority interest discount and a 40% discount for lack of marketability equals a total of 58% discount from value of control shares
$10 per share
Control premium
Minority interest discount
Value of minority shares if feely trades on an active public market (Publicly trades equivalent value or “Stock market value”
30% minority interest discount
42.9% control premium
$7 per share
Discount for lack of marketability
40% discount for lack of marketability Value of
nonmarketable minority (lack of control) shares
$4.20 per share
76
The Continuum of Value
Liquidation
value
Probable range of
fair market value
Strategic or
Investment value
Lower Higher
Price
77